What Constitutes Insider Trading?

Insider trading is a scandalous term that is often thrown around among stock traders. If you are accused of insider trading, you could face some very stiff penalties from the government. Here are the basics of insider trading and exactly what constitutes it.

Two Types

Technically, there are two different types of insider trading. One of them is perfectly legal while the other is definitely illegal. The legal form of insider trading involves employees purchasing the stock of their own companies. This is perfectly legal and encouraged. Whenever an employee purchases stock from their own company, they have to register the transaction with the SEC.

The other type of insider trading is illegal. With this scenario, a trader makes trading decisions based upon information that is not privy to the average investor. They have inside information that gives them a leg up on the rest of the market and they act upon this information.

Employee Insider Trading

One of the most common forms of insider trading occurs when an employee of the company buys or sells stock in the company. While this is legal under normal circumstances, it is illegal if you have inside information. Many times, corporate officers and executives will buy or sell stock in a company based upon knowledge that they have from working with the company. When this happens, they are guilty of insider trading.

Associates

In many cases, friends and family members have been caught up in insider trading scandals as well. When this happens, an employee of the company tells a friend or family member about some important information regarding the company. The associate then buys or sells stock in the company based upon this information.

Banking Employees

Sometimes employees that investment banks or other financial institutions will learn about important information regarding certain companies. When this happens, if they act on this knowledge by buying or selling stock, they could be accused of insider trading.

Government Employees

Many government employees also are privy to inside information whenever a company files financial statements with them. If a government employee takes this knowledge and uses it to profit or avoid loss, they are guilty of insider trading.

Giving Information

You also do not have to necessarily be the one buying or selling the securities in order to be guilty. If you are the individual that has inside information from the company and passes it on to someone else, you are contributing to insider trading which is also against the law.

Why It's Illegal

Insider trading is illegal and punishable by time in prison. One of the most famous scandals involving insider trading included Martha Stewart. She went to prison because she engaged in insider trading. This practice is illegal because you are taking advantage of your access to private information in order to gain financially. Other investors do not have access to this same information so it provides you with an unfair edge over the competition.